The Emergency Economic Stabilization act of 2008 was signed by President Bush on October 3, 2008. The main focus on the bail-out bill was to stave off further economic panic. These provisions were discussed in earlier editions, “Primer on the Sub-Prime Mess” (Volume 2, No. 3) and “Sub-Prime Mess Continued (Volume 2, No. 4). This edition will discuss only a handful of the more than 300 tax law changes included in the bail out bill and some sundry year-end tax concerns.
MORTGAGE FOREGIVENESS DEBT RELIEF EXTENDED
The Mortgage Forgiveness Debt Relief Act of 2007 (Act) provides tax relief to defaulting homeowners who might otherwise owe income tax on the forgiven portion of their mortgage obligation that was to have expired in 2008 The Act, extended through 2012, makes nontaxable debt forgiven on a qualified principal residence (QPR) with certain limitations as follows:
1. The relief applies to debt forgiven between January 1, 2007 and December 31, 2009.
2. Qualified principal residence is a residence as to each taxpayer meeting the same definition as under Section 121 relating to the home sale exclusion of $250,000 ($500,000 for joint returns).
3. The debt must be secured by a QPR and be either:
a. Acquisition indebtedness up to $2,000,000 ($1,000,000 on a MFS return, or,
b. Home equity indebtedness up to $100,000 ($50,000 on MFS return) to the extent that when added to other QPR debt the total debt does not exceed the FMV of the residence.
4. The amount excluded from income reduces the tax basis of the property immediately.
5. See Volume 2, No. 1 for situations that might require the assistance of a tax lawyer.
ALTERNATIVE MINIMUM TAX
This alternate tax system was added to the tax code to make sure that the very rich pay at east a minimum amount of tax. The AMT has different income inclusion and tax deduction rules, exempts AMT taxable income up to an exemption amount and employs a different tax rates. But, because congress did not index the exemption or tax rates for inflation, the threshold for taxability has become low enough to ensnare many middle class taxpayers. Hit especially hard are those paying state income taxes not allowable as an AMT deduction.
The government has budgeted and spent the windfall revenues from middle class AMT tax and now finds it hard to eliminate the unintended tax on the middle class. Instead, congress has once again implemented a temporary patch for 2008 that abates the impact on the AMT on the middle class by raising the exemption amount to $69,950 on joint returns and $46,200 for single and head of household filers. Married persons filing separate returns are allowed an exemption of only $34,975.
Florida has no income tax and the AMT is less prevalent hitting mostly those with large real estate taxes, miscellaneous itemized deductions in excess of the 2% limit (outside sales persons) or exercising Incentive Stock Options (ISOs). There is special relief provided to executives who’d exercised ISOs before 2008 by accelerating the offsetting AMT credit on the later sale transaction.
SOME OTHER EXTENDED TAX BENEFITS
The following expired or expiring tax benefits were extended:
1. The higher education tuition deduction of $4,000 subject to an income phase out (2009).
2. Additional $500 standard deduction for real estate taxes (2009).
3. Teacher’s classroom deduction of up to $250 from gross income (2009).
4. State and local sales tax deduction (2009).
5. Tax free distribution from IRA’s used as a charitable donation for taxpayers over age 70 and 1/2 (2009).
6. Residential energy property credit for qualified energy efficient improvements (2009).
7. Special election to expense depreciable property purchases up to $250,000 (2008 only).
SURPRISE CAPITAL GAINS WHEN TOTAL HOLDINGS DECLINE IN VALUE
Many taxpayers who hold mutual funds or investment management accounts assume that because the stock market has radically declined they will have incurred capital losses during 2008. Many will be surprised to find that instead they have an additional tax to pay on April 15, 2009 from mutual fund capital gains distributions or managed account trading activity. This is due to:
1. Mutual fund managers may have sold long held stocks fearing erosion of prior appreciation. These long term gains will appear on your Form 1099 DIV for the year.
2. Investment account mangers similarly may have traded to preserve gains or adjust your asset allocation. These trades produce gains even though your total portfolio value has declined from the previous year.
3. Unrealized losses in your account are not tax deductible until there is a trade.
Some suggestions to avoid unpleasant surprises:
1. Don’t buy mutual funds between now and December 31 without asking the fund manager whether capital gains have already been distributed.
2. If you already own mutual funds check with your fund manager about the amount anticipated capital gains distributions for 2008. Distributions are usually made in December.
3. If you have an investment management account with a trust company or brokerage firm check with your account manager about capital gains already realized and unrealized losses that might be available to offset gains by selling before year end.
4. Make sure to wait 31 days if you want to buy back a security you have sold to take a loss to avoid the wash sale loss disallowance rule.
COLLEGE SAVINGS PLANS
If you have established a Section 529 college savings plan, IRS present rules permit only one investment change per year. This rule hampers asset reallocation in volatile markets. You can reallocate, however, if you change the beneficiary. This might also be a wise move if the account has lost substantial value and the existing beneficiary is in college or nearing college age. Switching to a younger beneficiary gives you more time to make up the loss as markets return to normal. These plans are valuable tools because the earnings build up tax free and are never taxed if used for education. You can make transfers to the account without using your lifetime transfer tax credit by utilizing the annual gift tax exclusion ($12,000 in 2008). This is also a good gift vehicle for grandparents.
2008 PLAN CONTRIBUTION LIMITS/ CATCH UP (>50)
401(k) - $15,000/ $5,000
IRA - $ 5,000/ $1,000
Simple - $10,500/ $2,500
VALUE OF ASSETS EFFECTIVELY EXEMPT FROM ESTATE TAX
2008 - $2 MILLION
2009 - $3.5 MILLION.